Notes From Underground: G-20 was in Korea looking for its Soul

The statements coming from G-20 central bank chiefs and finance ministers in South Korea tried to calm the markets nervousness about currency wars. Brazilian Finance Minister Guido Mantega didn’t attend as a form of mild protest to what he felt was previous inconsistencies between words and actions. The U.S. had put forth a proposal that was leaked to the media ahead of formal proceeding for some numerical target on current account surpluses and deficits. In the final communique no formal targets were established.

In the final group photo, which appeared on the front page of the weekend Financial Times, Geithner and Bernanke don’t look happy. The most positive result from the “discussions” was the decision to rebalance the voting power ratios so that emerging economies will attain more influence. Also, the Europeans agreed to give up two seats on the executive board, which will go to emerging countries. These are good things as it gives a nod to changing the atavistic colonial nature of the IMF and other world financial bodies. Overall, the G-20 communique again promises much but is/will be light on action.

For me, the bigger story is how Geithner seems to have dominated Bernanke by appearing to usurp the FED‘s two-pronged mission. The U.S. came under heavy assault on the global stage for using Quantitative Easing as a policy tool to weaken the DOLLAR. Legally the FED is not in control of the DOLLAR for that is the baliwick of the U.S. Treasury. If Bernanke and his apostles are trying to stop the halt of deflation through monetary creation–that by definition will mean a weakening DOLLAR–which at some point will lead to inflation. It seems that Geithner was very defensive about the bout of DOLLAR weakness and seemed to want to use this as a compromising tool to get China and others to negotiate toward a greater restructuring of its domestic economies. If Geithner got a promise from Bernanke to pull back on QE, hasn’t the FED totally compromised its independence? All the rhetoric about the need for an enhanced QE program will have cost the FED its credibility.

Bill Dudley was so aggressive on his QE stance that somebody better phone him and let him know that the global arena has superceded all domestic needs. No, again I stress that there is no ostensible proof of this but the more I have read, the greater the chance of this having taken place. It will be interesting to see if the market begins to sense that there is a pullback from a shock and awe QE plan. If this is to be the case, the risk-off trade will be the main ingredient to trading. I really believe that the selloff in certain assets will be short lived. The DOLLAR will rally. Commodities will be sold. And, of course, equities will be hit. We caution that an equity selloff will be of short duration as stocks are on the rise for more than just the September 21 FOMC statement about QE. Global fund managers are busy trying to chase a rally that they missed since September 1 and they are looking for yield from high-quality, dividend-paying global equities. I will write more about this as we get closer to the U.S. midterm elections.

An aside to Mr. Geithner: When you go into a global meeting and are looking to grab the high ground it is unwise to invoke a policy that calls to question your real stand. I am referring to the EPA‘s move to raise the ETHANOL MIX levels two weeks ago as an election ploy to gain more votes in the agricultural-based states. Brazil has been angry about the U.S. ethanol policy for several years. U.S. farmers and ethanol producers both benefit from the tariffs and subsidies that aid the ETHANOL industry to the detriment of Brazilian sugar-based ethanol. Brazilian President Luiz Inácio Lula da Silva tried to get Obama to remove the tariffs, but Obama would have no part in undermining the agriculture lobby.

Again, we stress that this policy is flawed from a TRADE and FOOD PRICE position. Since the EPA announcement, soybean prices have rallied as well as other grains. Mr.Obama, we were very open about our disdain regarding corn-based ethanol with the BUSH administration but Mr.President, you are making the same mistake for domestic political reasons and it has cost you big at the G-20 and beyond. Global food prices are climbing even as the American Farmers bring in another giant crop. What will happen if we were to get a serious drought in the U.S. heartland? When it comes to FREE TRADE, political expediency trumps all rationale and the cost is U.S. prestige on the global stage.

Jan Hatzius at GS forecast on QE2 this AM: The scuttlebutt has been $500B or so in $100B a month dribs and drabs. He says(and GS a primary dealer with the Fed) $2T. Blow that bubble up, and whatever you do don’t sell your bonds yet.

Jill—I saw Jan’s output and I think at the nov.3 there is no chance of that announcement —unless the democrats continual to hold both houses for the equity markets will get hit if that happens as a split government is being priced into the equities.The equity rally has taken the immediate need for a huge QE and buys the FED some time to see what the rally is built on—sometimes I think that Goldman people throw out crazy numbers because it gets headlines—remmeber 200 dollar oil—still waiting.More intersting was Mishkin’s piece in the FT today and its timing.